musings about startup companies and entrepreneurship

When we went out and raised the first time (four years ago), we hit our fundraising goal. We had additional investor interest and almost closed the round. Instead, our advisor pushed us to keep going and we raised two times that amount. The second time we raised, we took on three times our target.

Not only do I not regret raising that extra money, I’m insanely happy we did. The extra capital funded the development of HelloSign (after HelloFax) and got us to cash flow positive. If we hadn’t raised, I would have had to go pitch investors during one of our most important inflection moments, when we were building and launching HelloSign.

I continue to see founders stop raising when they still have investor interest and momentum. I’m not talking about tens of millions of dollars, but the difference between $500K and $1M or $2M. It’s the kind of difference that gives you another try when your first hypothesis doesn’t work out or allows you to scale your company during a financial crisis.

Here are some reasons to raise more than you think you need:

1. Your startup is generally a binary outcome – success or failure

Within reason, dilution doesn’t matter as much as just succeeding. Having enough time to solve the problem you need to solve is the most important. Everything else is secondary.

2. Think of the money in terms of how much it can increase the value of your company

If $1M dilutes you by 10 percent, can you add another 10 percent or more value? If yes, then raising is a no brainer. (Paul Graham: The Equity Equation)

3. Chalk up $500K to a pivot, the discovery process, being a first time founder or making dumb decisions

Fully loaded (monthly salary, insurance, office space, office cleaning, gear, snacks, and more), some of our investors say you should estimate each employee costing $10K-$20K per month. I thought that was BS, until we looked at the cost of office space and the tons of other expenses.

Regardless, at the lowest end of the spectrum consider this: 10 people, on zero revenue, spending five months working on the wrong thing, will cost you at least $500K. So whatever you calculate as what you need, build in another $500K.

If you’re killing it, you now have extra fuel to put in the fire. You can take advantage of a game time opportunity, rather than needing to immediately raise more capital, which takes time. Plus, you may be in a financial crisis and not be able to raise growth capital even when you’ve built out the metrics proving that additional money would have an immediate ROI.

5. If your company doesn’t do well, you have time to fix it

If you’re in the middle of a pivot or still searching for the right users, extra money means extra time to fix things.

6. Even $1M on zero revenue doesn’t last long

Eighteen months goes faster than you’d imagine. If you’re raising for the first time, $500K or $1M seems like a mind-blowing amount of money. Then you calculate salaries, insurance (health, office, E&O, D&O), office space, legal fees, nice Apple cinema displays and other expenses you’ve never considered — on zero revenue. You may wake up one day to realize you’re out of money and your company has failed (Don’t be the startup that accidentally runs out of money).

7. You can acquire users with longer payback periods

If you have a profitable campaign with a six month payback period but not enough money to invest and wait for that money to come back, you’d have to shut down profitable campaigns. That’d be frustrating, since you’d literally have a profitable campaign on hand, but wouldn’t be able to take advantage of it. This is similar to number four.

8. The economy is like your crazy uncle — you never know what it will do next

In 2008 funding dried up. That was it. The financial markets took a dive. It was a bad time for many companies trying to raise. It was a time when investors with sterling reputations decided not to wire the money, even after committing. It was a time of huge uncertainty and a really bad time to raise.

The difference in a few days separated those who could raise and those would couldn’t, despite any company merits. It would have been nice to to have cash on hand to weather that kind of storm. Being unable to raise at these moments can kill your company and it often does. Never experienced a financial crisis? Talk to the founders that raised in 2008.

9. Your next raise is going to be harder

Each time you attempt to raise another round things get more difficult because the expectations increase and the valuation of your company is also supposed to increase.

The only thing that matters between the angel round and VC round is having enough runway (capital) to make sure you get your numbers. Raising without the numbers is extremely difficult.

10. Lots of small angel rounds are distracting and demoralizing

Fundraising is highly distracting and fundraising every few months is even more distracting. I’ve seen companies in the middle stages where they’re not quite at the A round stage, but continually raising smaller amounts like $200K or $500K only to have to raise that amount again.

There are better ways to spend your time like running your company and making sure you hit your numbers for the next round. Constant fundraising may prevent you from hitting your numbers in the first place.

Just as important, having to continually raise can actually make it more difficult to raise altogether. It’s like a self fulfilling prophecy. If it looks like your company is having a hard time raising because of the repeated effort, it sends the signal that your company isn’t worth the investment. The more it looks like you’re struggling to raise, the harder it will be to raise.

11. Consolidation of legal costs

It costs a lot of money to raise. You may spend up to $30K or more on legal costs. That’s pretty painful, but it’s less painful when consolidated into one bigger round versus multiple smaller rounds.

Just like our advisor made the case to raise more, I’ve made the same arguments to founders. I usually just get a polite nod. We did the same polite nod, but we have an unusually insistent advisor, which is exactly what we needed. So, this is me being unusually insistent as well. Raise more than you think you need.

I’ve interviewed a lot of jacks of all trades, masters of none. The problem is, they can’t do the one thing we need done really well, so we always pass. I’m starting to realize that we’re looking for the Jack (or Jane) of all trades, but master of one. They have at least one function that they focus on and absolutely kick ass at.

At a startup, employees perform a lot of functions. I think that people oftentimes confuse an employee like that as a jack of all trades, master of none. But in reality, when we hire someone we’re looking for the best candidate for a specific role. In a scenario where both candidates are good at hustling, we’ll always take someone who’s specifically very good at marketing, for example, over someone who’s okay at a lot of things, but not great at any one given thing.

It’s important to ask yourself these questions:

“Who’s going to be the best at growing your userbase? An average marketer or the best marketer you can find?”

“ Who’s going to be part of a marketing team you’re building long term, someone who loves marketing or someone who just likes it?”

“Who’s going to build you the best possible product? A product manager who just dabbles in product, along with everything else, or someone who absolutely loves and kicks ass at it?”

If I were thinking about my career in the startup world, I’d think about the one area in which I could be the best. Would I be a great marketer or a great product person or something else? Then, I’d do the everything I could to be the best at that role. Whenever we interview someone who’s jumped from product, to marketing, to something else, we’re not sure how to think of how they’d fit in our company long term. At a certain point, the Jane of all trades need to focus on something, and when that happens, will she be the best person for that role? Just like most things, focus is really important. If I were getting started in the tech world, I'd think about where I could truly excel and focus on that.

I realized the other day that we’ve grown from $0 to $1 million with two separate products (HelloSign and HelloFax). This happened a long time ago, but I was recently reflecting on the lessons.

I found a lot of growth truisms to be false. We’ve learned a lot. Some lessons were painfully won, which is why I may sound strongly opinionated about them. They also may be slanted towards B2B products, but I wouldn’t discount them if you’re not in that space.

Here are our lessons:

1. Charge for your product as soon as possible. Really.

Every founder I talk to has a good reason for not charging for their product and it’s usually a bad reason. I remember office hours with Paul Graham. We explained that we were focusing on product now, but would focus on revenue later. He was confused, that somehow we saw a tradeoff between focusing on product and focusing on growth. Building product should equal growing revenue. People show they value your product by paying for it.

2. Revenue tells you what features to focus on

Charging is a powerful indicator that you’re building something people want. If you’re not charging, you’re likely spending money (development time = money) building features your users don’t really want. People who pay you have opinions about what to build next. Making them happy will lead to more people like them paying you (with this caveat: Don’t build a Galapagos product)

3. Focus on the right customer

YC and Paul Buchheit often say find one user and make her happy. I’d amend that. Find one user in a big market that has the highest LTV, lowest churn, and focus on making her happy. Otherwise, you may be boiling the ocean.

4. ‘You have a distribution problem, not a product problem.’

After one board meeting, our investor said, ‘you have a distribution problem, not a product problem.’ It’s a lot easier to change your message and re-focus on a different target market than completely changing your product. Do that before pivoting or rebuilding your product.

5. “Cheaper and better” doesn’t necessarily lead to higher conversions

Cheaper and better is another truism I found mostly false. Customers often doubt a product is better, because it’s cheaper. Strange, I know. I remember one of the Wufoo founders explaining the notion of being more expensive and better. Plus, if you charge more, you can invest more in product and truly make it better.

In fact, I met one CEO who deliberately priced his product higher than his competitors, just to get them to ask, ‘why’. Then, he’d pitch why his service was better than the competitors. When we split tested our pricing, just being cheaper didn’t lead to higher conversions.

Maybe there’s some scenarios where cheaper and better could make sense, but I think this truism needs to be questioned and perhaps the default truism should be reversed: be more expensive and better.

6. Being too cheap or free can lead to less growth

It turns out that distributing to businesses takes money and effort. They don’t just show up. Since we had cheaper plans, we couldn’t afford to reach out to more customers. But, with more expensive plans and a higher LTV, we can spend significantly more to acquire customers.

Being ‘cheaper’ and ‘better’ really just makes it so you can access less people.

7. There isn’t a strong correlation between beautiful design and success (in the early days)

Let me preface this by saying, we love design. I’m a huge fan of design and we’re making a big investment now. I think it’ll help us get to the next level.

I remember meeting with Garry Tan, who is an incredible designer. He mentioned that he hasn’t seen a strong correlation between good design and success of startup companies. So, if you have to choose, pick great user experience, then add great design later.

Conversely, focusing on pixel perfection in the early days may even prevent you from getting the revenue you need.

8. Free plans often make business leads feel uncomfortable

A huge customer wanted to use us for thousands of seats. Instead of being excited by our free plans, they just got confused. We lost them. That was painful. Not paying means that you may not be around forever. Paying money for software signals that they can depend on you for this really important function in the future.

Startups underprice all the time. As a business, we signed up for a $15 / month tool. I would have paid $100 / month for the value it provided. I had an unusual moment, where instead of getting excited about how inexpensive it was, I got nervous about using a key piece of software for only 15 dollars per month.

9. Don’t listen (too much) to your users on pricing

Innovate on your product, not the pricing. We’ve tried all types of innovative pricing models, often driven by our user-base, which have resulted in a lot of custom development. Ironically, when we switched back to industry standard pricing, the plans performed significantly better.

10. $5 / month is too cheap

If you’re a business tool and charge $5 / month, you’re likely leaving a lot of money on the table. Justin Kan said that we were running a charity. He was right. We doubled our prices. See #9.

11. Split test pricing early and often

Two years after launching, we doubled our pricing without an impact on churn or conversion. Since we grandfathered all of those users, we have two years of paid plans that could have been paying us $10 / month versus $5 / month. If we had done this split test earlier, we would have effectively doubled our revenue.

That could be the difference between succeeding and failing as a company.

12. Try to be profitable, at least once

I often meet with founders who tell me that they’re working on free user growth. I’m going to say something controversial: with rare, rare exceptions, you should never just focus on free user growth at the expense of revenue unless you’ve previously been profitable or run a profitable company. I don’t think most new founders know how to make the optimal tradeoff between free and paid user growth.

I remember having office hours with Emmett Shear. I explained that we were focusing on user growth, at the expense of revenue growth. He asked if our company would be harmed by focusing on revenue for six months? From that moment on, we started one of the biggest revenue ramps we’ve ever had.

If you’re not convinced, you should read this amazing article by Mark Suster on revenue.

13. Your number of paid plans will gets messy, and that’s ok

I remember being reluctant to split test pricing plans, since it’d produce more paid plans to support. Then, we did it. Sure, it’s extra work to support them, but it’s well worth it to double your revenue.

14. Prosumers have higher churn

Yep, and the difference is dramatic.

The only way for prosumers to potentially work is if they have an extremely high frequency activity with your product – something they do so often, they see so much value, that they pay, like Evernote or Dropbox. Plus, there really needs to be a massive number of people that could use your software. However, that type of mass market prosumer software is few and far between.

15. The Dropbox referral page is amazing for Dropbox, but does it work for you?

Dropbox has an amazing referral page, where users can perform actions, like inviting friends, in exchange for free storage. It’s been a big source of growth for them and I’ve seen a lot of other companies try it. Of all of the companies I’ve met, I’ve never heard of it becoming a meaningful source of growth.

Some founders react to this feedback by lowering their prices. That’s typically the wrong thing to do. If someone doesn’t use a product often, she’ll always complain about the price, because she won’t see the value in it.

That just means she’s the wrong customer. Instead, find people that use your software often or fix a bigger pain point. See #3.

17. Startups will probably be your first users and complain the most about pricing

Be careful about listening to them, otherwise you may start developing your product or pricing in unnatural ways, which have nothing to do with the real market. We’ve done that and regretted it.

18. Free users make the most noise, but pay the least

We certainly give the best support possible to our free users, but we take their feature requests with a grain of salt. If you listen too closely, you may take your product in suboptimal directions. Build features for the people that pay you.

19. Month on Month (MoM) growth is key

I can’t emphasize this enough. This is what separates lifestyle businesses and startups (PG: Startups = Growth). Build 20 percent+ MoM growth and you could be the next Dropbox.

20. It takes years to stack revenue

Even with high growth, revenue takes time to grow. Average IPO is 7-13 years. It takes time to stack paid plans every year. But, if you have high MoM growth and minimize churn over time, revenue adds up.

21. Eventually, you need marketing and sales

The danger of the product CEO is that when you love product, every solution is a product solution. Dropbox is one of the very, very, very few companies where this worked out – a group of MIT grads sitting in a room, building great product and viral loops.

However, in the more common world, word of mouth only gets you so far. Marketing, Sales and BD are what make companies grow. Great product just makes it easier.

I met with someone who buys startup companies at low prices that are running out of money. He then implements very standard tactics to make them grow revenue. None of these things are rocket science. These companies then turn into revenue machines. His impact is immediate and mind-blowing.

It’s unfortunate that the founders missed the chance to drive it themselves. Founders will often wait for a natural lift in growth and will keep changing their product until it gets there – even when changing the product no longer make sense.

22. Small variances in churn can have a massive impact on revenue growth over time

This is the best graph on churn I’ve seen. Small differences in churn has an exponential impact on your MRR over time. See below.

Unless you get control of churn, your growth will eventually stop, since churn will cancel out any new upgrades. It’ll become more and more difficult to replace churned users over time.

23. Annual plans are amazing. Implement them ASAP.

You offer your users a discount for the year and in exchange, you get approximately 10 months worth of revenue right away (depending on how you discount), rather than one month of revenue each month. That can easily make the difference between being cash flow positive and burning money. It can also reduce churn and many of your customers prefer them. Win, win. Plus, when those renewals hit after one year, your revenue takes a big jump. If I were you, I’d implement annual plans ASAP.

24. Engagement is a leading indicator for revenue

Engagement is flat, but revenue growth steady? That probably won’t last. There’s only so much you can do before paid upgrades decrease.

25. Focus on a limited number of metrics

As much as I love metrics, focus your attention on just a few. I’d pick one revenue growth metric, one churn metric and one engagement metric to start. Then, grow your metrics dashboard over time. When you do, implement this one.

We started out with a metrics setup that was really complex and all we got was a lot of wasted time and an important lesson.

This may be controversial, but I completely pulled our free user growth slide from our deck and stuck it in the addendum. Investors were way more receptive to our pitch. Free user growth is just a proxy for future revenue. So, if you have revenue, just show that instead.

27. Hone in on ‘deal breaker features’, not feature requests

There’s something powerful about someone saying they won’t sign up unless you have X feature or canceling because you don’t do Y. Anyone can have a feature request. Few people will vote with their feet.

Building those deal breaker features will produce more revenue.

28. Always know your runway

I still meet with founders getting blindsided when they realize they’re almost out of money (Don’t be the startup that accidentally runs out of money). Knowing your runway allows you to make smart decisions about revenue and fundraising, early. Just knowing when you’ll run out of money is healthy, since it guides your daily decisions on revenue.

29. Your free users are for marketing

I remember an experienced CEO explaining to me that free users are just one part of the funnel. She thinks of supporting those free users as part of the marketing budget. They spread the word. They become engaged and upgrade later. But, think of them in that context.

30. Growth is not magic and it isn’t a black box

It’s something companies do or don’t. They do it well or don’t. There are tried and true tactics out there.

I see a lot of almost desperate innovating when it comes to growth. Sure, keep looking for the hacks and viral loops. Maybe you’ll come up with your own equivalent of the Dropbox referral page. But, while you’re doing that, there are a ton of sources of growth that are tried and true over the years. You just have to build those channels: BD, PPC, SEO, channel partners, PR, content, API evangelism, viral and more.

31. Business development can do wonders for revenue, if done right

We learned a lot of business development (BD) lessons, some of them were painful. There are a lot of pitfalls when it comes to doing BD when you’re a startup. But, it can (and has) become a huge source of growth. Here are some of the lessons I talked about at a talk at 500startups.

32. Doing paid advertising can improve your entire funnel

There’s nothing like paying money for advertising to make your entire funnel more disciplined. We changed our onboarding, emails, and pricing, all to make our campaigns profitable. The paid ads were only a minuscule part of our growth. But, the rest of the product hugely benefited from those optimizations.

33. Product market fit

34. Do post mortems on every release

It’s humbling when you make a big investment on a feature, only to have no one use it or pay for it. Do this once and it completely changes how you think of every feature you build.

35. Customer development != growth

Do customer development to focus on the right users. But, don’t get stuck in customer development / research cycles. Customer development is important, but should have a completely different place in your mind as growth. I see lots of companies stuck in customer development cycles, but as a consequence, these companies might never focus on distribution.

36. All word of mouth growth makes some investors nervous

Word of mouth is nice, but it’s not predictable. You need predictable growth.

37. If you build it, they won’t just come

I’ve seen companies go under, waiting for the users to come. They never came.

38. It’s less stressful when you generate revenue

Startups can be stressful. A lot of people have written about founder depression – it’s a real thing. Sam talks about how founders have a lot of weight on their shoulders. Having revenue can significantly ease that weight.

39. Put together a hypothetical pricing page with a spreadsheet and how it’d look when you fill it out with features

That spreadsheet will help guide product development, since everything is connected to revenue. Put higher value features on the higher plans.

40. Customers don’t price shop as much as you think

Our price, in relation to our competitors, doesn’t come up often. Sometimes we’re more expensive, yet we might still win the deal. So, don’t become too obsessed with your competitor’s prices. Just optimize for your users.

41. If you’re only winning on price, rethink the value you add

Unless you’re Amazon, a price war can be brutal. Instead of being cheaper, think about how to differentiate.

42. Consumers and businesses behave differently when it comes to money

As a company, we pay a huge amount of money for software and don’t flinch, but in my personal life, I’m still on a free Spotify account. Many founders don’t have real work experience before starting a company, myself included. Without being in a work environment, it’s hard for a founder can imagine how much companies pay for software, which leads to underpricing their product.

43. If you’re a SaaS product, read this post over and over again

Revenue isn’t a bad thing. Want to know what we do with revenue? We support a team of terrific people that help us build and support this product. Every day we make the product better, because we have revenue. The more revenue you have, the better you can make your product for your customers.

For some reason, the mental default for founders is that their product should be free – and charging needs to be justified. The inverse should be true – the mental default should be that your product should be paid and being free should be justified.

In fact, most pricing truisms should be reversed. Statements like “cheaper and better” should need to be justified, instead of spoken and accepted as truth.

Today is a good day to grow revenue! No reason to wait. I find it weird that I meet with founders and have to convince them that growing revenue is important. Then, runway decreases, they can’t raise, the game is over and everyone acts surprised. (Don’t be the startup that accidentally runs out of money)

In fact, if you this figured out, you may get to the mythical, ‘infinite runway’. Then, if you want, you can turn on the spigot and operate at a loss in exchange for revenue growth. That’s the moment increasing your burn rate for growth makes sense, but rarely before.

Years ago, I was interviewing a marketing candidate. I asked general questions about how she could meet certain growth goals and she talked about the marketing campaigns she would put in place for us, like SEO, social, PPC and more.

After the meeting, I thought over whether she'd be a good fit. I realized that I had absolutely no idea how well she'd perform. The things I learned were too generic and nebulous to evaluate.

Anyone can suggest SEO, PPC, PR or any of a dozen other marketing strategies. Plus, it turns out that if you ask if someone can do something, 95% of the time they’ll say yes, which is very unhelpful in assessing a candidate.

Now I focus the vast majority of every interview asking about what people have done, rather than what they could do. What’s the best campaign you’ve launched? Was it successful? What metrics did you track? Did you make any mistakes? If so, what were they? What was your biggest management challenge? Then, I do a deep dive into each of these areas and try to understand what they did and how they interacted with others. I found that the great candidates really enjoy these deep dives, since it gives them an opportunity to really show their skill set and experience.

These answers will tell you how the candidates operate in real life. As soon as I started focusing on their past details, I got a better sense of who they were as a candidate and whether they’d be a great fit.

I remember office hours with Paul Graham in 2011, when we were giving yet another excuse for waiting to launch. We wanted to build x,y and z features before launching. Paul Graham advised -

“Launch when you have a quantum of utility”

We launched and it was the best decision we made. Instead of building what we thought users wanted, we could talk to our users and ask what they wanted.

There’s a tendency of new founders to wait almost indefinitely before launching. I’m always surprised when I meet with these type of founders. Everyone has heard that you should launch fast, yet the founders I meet always have a reason why it doesn’t apply to them.

There's a company I used to know that went months and months without launching. It seems like everyone knows a company like this.

One month becomes two, then three, then four and still no launch. It makes me nervous. I wondered, what are you working on that absolutely needs to be built before launch? When I hear the features that they absolutely need before launch - none of them seem like show stoppers.

They were wasting money and time - the scarcest resources as a startup - on something they didn’t know their users needed. The more time that passes before you have a live product and you're talking to customers, the more likely you're building something you think your users want, versus what they actually want.

When I think of the massive lists of features that founders have to build pre-launch - I always have this image of the Coyote running on air. Last minute, he looks down and realizes he’s not standing on anything and falls. These founders have never launched a product before, so it isn’t their entrepreneurial experience that is telling them to wait.

I thought of a new rule. The less experienced you are as a founder, the faster you should launch. Or, listen to PG’s advice and launch when you have a quantum of utility.

I can’t tell you how many times I’ve had this conversation. A founder is about to raise their first round and asking me how to value their company. [1]

There’s a reason it’s so difficult to figure out - valuations have little basis in reality for early stage companies. You evaluate the team, product, market and other variables - then, make a general guess.

Before I go on, if you read nothing else, read this:

Your #1 goals is to get your company funded, so you can build a big business. Funding lets you invest in growing your company faster than revenue growth would normally allow. Do what you can to get your company funded and get back to work generating value.

Here are some ways to value your company:

1. Market size

A big market determines the upside potential. In a world where only the 1000x companies make back portfolios, this is really important. [2] This can often justify a higher valuations - and for good reason. For some investors, this is the most important attribute and they won’t invest unless it’s a huge market.

2. Revenue

Revenue is how traditional businesses get valued. Early stage companies often don’t have revenue or have revenue so low, it’s not a real indicator of future potential. Companies like Facebook and Twitter didn’t figure out revenue for a long time. This is the main reason the process of picking a valuation can feel so ambiguous. With that said, if you have revenue, this is something you should emphasize.

3. Month on month (MoM) growth

To become a big company, you need high MoM growth for years (PG: Startups = Growth). 20% MoM growth is the gold standard - the longer and more consistent you hit high MoM growth, the better. Even a product an investor doesn’t fully understand - for example, an app that self-destructs the photos it shares - starts to look really good with high MoM growth. This works for revenue or active users.

4. Active users

Free, engaged users are a proxy for revenue, as long as you understand when a free user is valuable and when it isn’t. The threshold is generally higher for consumer startups (Ten million users is the new one million). Moreover, the engagement of your paid users are also important, even though they’re paying you, since it’s a leading indicator of churn.

5. Team

Everyone talks about the Stanford / MIT teams. It certainly can help boost a valuation, but isn’t necessary. Domain expertise can also help.

6. Valuations of other companies like you

Relationally, you can compare your valuation to other companies on Angellist, Y Combinator, 500 Startups or elsewhere.

7. Acquisitions of other companies like you

This is helpful in determining a valuation, since it shows real liquidity for what companies will pay for a company like you, instead of what an investor will pay to invest.

8. Raising momentum / high demand

This method of valuing a company is further from reality than most attributes. If your company is in high demand, it drives the potential valuation up. Hopefully, it’s in high demand for good reasons, otherwise you risk a down round in the future.

9. Accelerator

Being part of an accelerator can help your valuation, since you’ve at least been partially vetted, which decreases some, but definitely not all, of the risk.

Things to note about valuation:

1. Your outcome will likely be binary

I spoke to a YC class about fundraising a few years ago and I still believe this - I’d rather raise $1m at a lower cap than $100k at a higher cap. The former will get us to the next stage as a company. The latter won’t be enough money to grow and without the capital to grow, could risk failing or a down round.

2. The valuation only exists if investors validate it

Traditionally, there’s a lead investor that validates a valuation, but a lot of companies now raise without a lead. By getting a few investors to buy in at a specific valuation, they’re effectively validating the amount. Either way, your valuation doesn’t truly exist until it’s validated.

3. Don’t risk a down round

A down round happens when the valuation of your next round is less than your current round. No one comes away from that undamaged. That can happen when people are too aggressive about their valuation in that first round. Don’t let that be you.

4. Terms often matter more than the valuation

For a higher valuation, you may be giving up some control, like a board seat. I’ve also seen people raise on 2x+ pro-rata, which means that the investor has the option of doubling their stake in the following round, which I think is generally a bad idea. I’d keep your terms as clean and standard as possible. [3]

5. Valuation pride

Why do people push super high valuations? It’s one of the few moments in your company’s history where you can get a stamp of validation. Just like good grades or good schools help drive your self-worth, a great valuation can do that too. It’s something you can tell others or use to compare. So, the bigger the stamp, the more likely you’re seemingly doing well. Don’t be tempted by this.

6. Map out multiple stages of financing

Take a moment and project out your equity over multiple rounds of financing. You need to make sure there’s enough equity to sell, while keeping enough equity for the founders and team. I hear of companies that sell 50% of their company for a few hundred thousands dollars. That won’t leave enough equity to sell for future financing rounds. (The Benefits of Building a Company in the Bay Area)

7. Drive for a ‘fair’ valuation

That probably depends a lot per company, but I kept that word in my head as I figured everything out.

Invariably, you’ll run into investors that think your valuation is too high. The only right behavior is to be consistently nice and explain your thought process (Treat investors well when fundraising).

10. Valuation versus percentage ownership

Some investors are more interested in the percentage of the company they own, versus the valuation. In that way, you might end up with a higher valuation than you would have had otherwise. You can certainly take this approach to picking a valuation, but just make sure you’ll be able to at least grow into that valuation - preferably grow significantly past it - by the time you raise your next round.

You’ve probably noticed at this point that there’s no clean formula. Even though it’s inexact, investors will want to know the thought process behind the valuation you pick.

Certainly, there are bad valuations, but there’s a larger range of gradations of good valuations and I wouldn’t stress about small differences between the gradations in the good range.

Good luck figuring this out. The key is to not spend too much time thinking about it. Some incredible companies, like Dropbox and Airbnb, got valuations that would seem extremely low in this market for their first rounds.

In the end, it’s your ability to execute that will turn your company into a big one - not your valuation. It’s more important to close the round, get the money in the bank and get back to building.

Would love to hear what you’ve learned about valuing early stage companies in the comments.

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[1] This is mainly about your first round. I think a lot of the lessons can apply to later rounds though.

We were comparing two SaaS applications. One gave us a better quote, so we asked the second if they would match it. They wouldn’t, but their founder, wrote us an email explaining:

Why their software is better

How their software would save us a lot of money and time

After reading it, we immediately picked the more expensive choice. I thought the email was so compelling that I wanted to share it as a great example of how to position a product for value vs. cost. I've anonymized the company:

Subject: Re: demo follow up

No worries... short answer is no, we aren't able to compete on price against FooCorp.

The FooCorps's of the world have spent a couple decades now in a the race to the bottom and it shows. I have no doubt you can get their product (or a whole raft of others) for a few bucks cheaper than us.

Our product, Acme, is different. We're designed to help improve your'e company's performance in the critical area of XYZ. The ROI on doing that is enormous.

Now, not every organization sees the value in investing in XYZ. I get that. But if yours does, Acme is one of the most leveraged investments you can make.

Assume HelloSign does 5-6 transactions in the [XYZ field], that's going to run 300-600k per year (so figure this is a $1-2MM investment over 3 years). The value of each transaction will be maybe 2-5x that if they're done well, whereas a bad one we know can actually destroy value.

On the cost side, great transactions churn over at less than half the rate of low performing ones - which means if you do a better job at XYZ, you'll save 10's of thousands in new transaction costs as they stay longer. And on and on....

So ultimately if you think Acme will help you do this better - even just a little bit - the whole thing is peanuts. The cost difference between our product and the others, even less.

Look, FooCorp's customers are switching to Acme in droves because we're investing heavily in great customer service and innovation. Those things cost money but, as we see above, they drive tons of value so the market is happy to pay.

We'd love to have HelloSign on board as a customer and I'd be happy to have another chat with you or them if you think it would be useful. Let me know!

Regards,

Acme CEO

The point is, instead of doing a price cut, it may be worth explaining why your product is worth more. This email will probably be worth millions of dollars over the lifetime of their company.

Either way, he was right. The minor different in price was worth it. The product is amazing.

In 2010, I moved myself and the company from Minnesota to San Francisco. There’s no way we would have been able to build HelloSign in Minnesota.

Every week or so, I hear about a new city that’s trying to become the ‘next Silicon Valley’ or someone explaining to me that Minnesota is a great place to build a tech company.

You certainly can create a good company anywhere. You can also sprint at 20,000 feet. It’s just significantly harder and you’ll be giving yourself a handicap.

If you'd like to see this topic discussed at SXSW Interactive, vote for the panel in the SXSW panel picker.

Here are seven reasons I moved:

1. Capital

There is a unique ecosystem of angel investors and venture capitalists in the Bay Area. It’s unparalleled for tech companies anywhere in the world.

Over the past 40+ years, the large exits and IPOs (Facebook, Google, Yahoo, eBay and more) have fueled and justified the next funds at VC firms. And they've produced a new batch of rich individuals who’ve become angel investors.

It’s this group’s unique understanding and affinity for tech that has helped produce incredible returns on investments -- which in turn has justified more capital entering the ecosystem -- which have in turn funded more great companies and so on.

We raised capital in the Bay Area in 2011. While we were fundraising and bloggers were calling the environment ‘frothy,’ the Minnesota Star Tribune wrote a long article about how angel investors in Minnesota were cutting back. These are two very different worlds.

2. High concentration of specialized knowledge

Knowledge is almost just as valuable as capital. Within walking distance of our office, you can talk to the people who built Twitter from the ground up and experts on viral growth. Want to learn about SaaS metrics? Reach out to the companies that set the SaaS standard -- like Dropbox, Box, Evernote and others. Even with their level of success, these people are remarkably open and accessible.

3. Culture of risk

My cofounder quit his full-time job at Tripit to take a risk building this company. In Minnesota, I’d be hard pressed to get anyone to quit their job to join a risky startup. Since there’s a lack of capital in Minnesota, starting a company is significantly harder for anyone with a family or any other life expenses.

3. Valuations

Valuations are significantly better in the Bay Area. Since there is a super high concentration of billion dollar tech companies, the returns justify the higher valuations. As one investor explained to me, it’s the Facebooks, Googles and Dropboxes of the world that make this possible.

Moreover, there is a high concentration of investors competing for the best deals, which produces a better market price on equity. Certainly, a too high valuation can also be harmful, since it risks a down round. With that said, over the course of multiple rounds, you need to maintain enough equity to fuel growth. If you sell too much, too early, it can stunt your future growth potential.

Outside of the Valley, one founder explained to me that it’s not uncommon to sell 50% of a company for a few hundred thousand dollars. If it’s a capital intensive business, it’s unlikely they'll have enough equity left to sell in order to make it into a big company. Investors, getting too much of a good thing, get a bad thing, which prevents their portfolio’s ability to grow.

4. Legal terms

It’s not uncommon to see companies move to the Bay Area and be stuck with crazy investment terms from a previous angel investor.

Let’s say an investor who’s invested $10k has the ability to veto an acquisition. Not only do custom terms cost a lot of money in extra legal costs, it can also scuttle a company’s ability to raise future rounds, since this small investor has an outsized impact on the future of the company.

Garry Tan explained to me once that Silicon Valley is a trust-based ecosystem.

Just like repeat interactions in the prisoners dilemma produce better behavior, so do repeat interactions in Bay Area. Founders and investors know that if they behave badly, they’ll get cut out of great deals in the future.

6. Community versus isolation

Ben Horowitz explains that the most difficult job as a founder is managing one's own psychology.

In Minnesota, no one understood what I was doing or why it was worth it. I constantly felt like a foreigner. I even remember demoing our product to a family member and the person just walked away. The day I moved out here, I demoed it for a friend - he was so enthusiastic about it that he then started introducing me to his friends. After working on the product for nine months in Minnesota, I never experienced that level of enthusiasm from anyone.

Starting a company is hard and doing it in isolation is even harder. In the Bay Area, you’re surrounded by a community of people who understand. That makes a huge difference when you’re building a company.

7. Business development and integrations (growth)

This is a huge source of growth for us.

The vast majority of the companies we work with are within driving distance. In the event there’s an opportunity, we can meet in person. I’m very confident that business development wouldn’t have been a source of growth from Minnesota. Here's a talk I gave last year at 500 Startups unSEXY conference about business development.

It’s hard to evaluate odds. Especially with outliers and a desire not to move. Groupon was based in the midwest (Chicago). Startups are generally binary. So, anything you can do to stack the odds in your favor, you should do. If it takes moving to the Bay Area to increase the chance that you’ll succeed, I would (and did) do that.

There are 33 more reasons to move, I just ran out of time. Vote for the panel and share your comments on SXSW Interactive's panel picker and I'll share more reasons to move!